External audits are mandatory under various jurisdictions, in particular for public companies. Even when there are no such regulatory requirements, some stakeholders, such as banks, may ask for external audits. There are several reasons why external audits are advantageous. Most importantly, these assure the users of the financial statements about the true and fair presentation.
During external audits, companies hire auditors to examine their financial statements and records. Based on their findings, these auditors then provide an independent opinion of the company’s financial situation. For external audits, auditors need to perform several procedures to obtain audit evidence. While external auditors can have significant advantages, there are also some limitations associated with them.
What are the Limitations of an External Audit?
External audits can have several limitations. These limitations may be inherent to the process. In some cases, they may also arise from the expectation gap existing between the users’ view of audits and the actual process. Regardless, it is crucial to understand what the limitations of an external audit are. Given below are some of the prevalent limitations of external audits.
Time
For most external audit engagements, time is one of the most prominent limitations. Usually, both the auditors and the client agree to the timing of the audit. Due to some restrictions, however, the deadlines may not be met. Auditors may, therefore, need to reduce their testing to meet the client’s expectations. In these cases, the quality of external audits may be compromised.
Time constraints are inherent to most audits. In most cases, auditors estimate the time it takes to complete the audit based on information obtained from the client. Practically, however, the audit may exceed the estimated times. Sometimes, the client may not provide the necessary information in the required time. Either way, these may result in time constraints, which is a limitation of external audits.
Threats to Auditors’ Independence and Objectivity
For any given audit assignment, auditors need to establish whether they will perform their work with independence. This independence is from the client or its management. It is an ethical issue that all auditors need to consider. For every audit engagement, auditors will need to assess their independence from the client and its activities.
There are five threats that may exist to an auditor’s independence and objectivity. These include self-review, self-interest, intimidation, advocacy, and familiarity threats. If any of these threats exist for any auditor or the audit firm, the external audit may suffer. Threats to independence and objectivity are inherent limitations of external audits. However, these may also apply to internal audits.
Use of Professional Judgment
Internal auditing standards exist to guide auditors on how they should conduct their procedures. In some cases, however, these standards may not specify the procedures auditors must use. Therefore, they will need to apply their professional judgment to make decisions. For example, auditors must use their professional judgment to determine whether the internal controls at the client are sufficient.
The use of judgment can be critical for any process, and the same applies to external audits. Overall, external audits are more subjective than objective. Therefore, auditors will need to use their judgment anywhere necessary. However, they may not always make the right calls. It may pose a limitation to their audit assignment.
Use of Sampling
Auditors need to use sampling in various areas where they cannot test the whole population. For example, it is prevalent for the test of controls and details. Auditors use sampling because of time constraints. While some guidance exists on how auditors can use it, they still need to use their professional judgment in these cases.
The use of sampling poses a limitation to external audits. It also contributes to the expectation gap that exists between the users and the actual process. Most users expect auditors to test the whole population, which is not true. Instead, auditors only examine a specific number of transactions and balances to reach an opinion. This process also introduces sampling risk to an engagement.
Nature of External Audits
As mentioned, some limitations also stem from the nature of external audits. Auditors can only provide reasonable assurance to clients based on their findings during the engagement. Some clients or users may think of this assurance as absolute. Due to time constraints or other resource limitations, however, auditors cannot do so.
These limitations also stem from the clients’ or users’ expectations of external audits. By providing a reasonable assurance, auditors only assure the preparation and presentation of the financial statements. It does not assure users of the financial viability of the client or its management’s effectiveness.
Conclusion
An external audit is a process in which external auditors examine a company’s financial statements and gather audit evidence. Based on their findings, they provide an opinion on whether these financial statements are free from misstatement. Although external audits are highly significant, they have some limitations. Some of these limitations are provided above.
